Money management in binary options trading

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Every experienced trader knows that the guarantee of productive trading in the financial markets is the presence of three key components: the presence of a reliable trading system, strict self-discipline and effective money management. Indeed, the combination of these factors determines the prospects for any successful trading, including binary options. As part of today’s review, we will talk about money management, or, as they say, money management, and try to figure out how to optimize the work with personal funds in the most correct way, as well as give some practical advice that can serve as a beginner as well as more experienced binary options traders.

What is money management?

To begin with, we will reveal the content of the concept of money management. Money management is a process of optimal and strategically adjusted cash management in order to maximize profit. Despite the fact that such an approach is one of the key and obligatory, one might say fundamental, factors of successful trading in the financial markets, money management often remains neglected as something self-understood. Indeed, many beginners say: “you need to carefully approach the management of the deposit,” and after that they make ten profitable trades and one unprofitable one, which “eats up” all the profits. And even then, left without money, a person goes to look for information on how to properly manage capital and understands that the success of trading is determined by long-term profit.and that experienced traders often have to make three or four losing trades in order to feel trend , adjust the strategy and cover this loss in one or two profitable trades. So, in fact, money management is the science of effectively managing your personal deposit for successful and long-term trading.

Money management rules

To begin with, here are some of the most general recommendations for effective deposit management.

As a matter of fact, there is only one recommendation at this stage of the review, but we will talk about it in detail. So, it reads: “Do not trade a deal more than 2% -5% of the total amount of the deposit.” For example, if your deposit amount is $ 500, then the transaction should not exceed $ 25, and regardless of whether you are trading profitably or unprofitable? the interest rate still remains fixed in the $ 10- $ 25 range. Do not neglect this rule of money management by all means. Over time, feeling more confident in yourself, you can raise the interest rate, say, to a range of 5% -7% or even up to 10%, but never go beyond the range you set, this will instill the necessary discipline and protect your funds from emotional waste. Sometimes it will be very difficult to resist what seems to be an obviously profitable trade.but you must overcome yourself even in such conditions. As the saying goes: “you drive quieter, you will continue.”

Next, let’s talk about some of the structural specific features of money management, or, you can also say, the key principles of money management, which should be in the head of every trader.

To begin with – a small plan within which we will develop the topic. And so we will analyze what it is:

  1. Sober trader
  2. Determining the size of the deposit
  3. Trade with the trend
  4. Determining the ratio of profitability to risk
  5. Plan your profitability
  6. Losses minimization rules
  7. Diversification of risks
  8. Trade by system, by strategy
  9. Kelly criterion or formula and flat as a money management system
  10. Oscar Grind’s system as a money management strategy
  11. Money Management and money management – is there a difference?

 

  1. Sober trader

As you know, a person who trades in financial markets, in particular, binary options, called a trader. And the main quality that distinguishes an experienced trader from a beginner is the ability to soberly assess both prospects and risks. Agree, of course, you can trade with a drunken head, and sometimes even successfully, on a wave of special intellectual inspiration, but as a rule, such a practice is doomed to failure. By and large, trading is a science expressed in the endless improvement of their theoretical knowledge and practical skills, and even the most enlightened traders spend a lot of time studying the subtle nuances of market dynamics, the specific features of fundamental and technical analysis, rethinking and improving their own trading system. It is this kind of fundamental and comprehensive approach that creates traders who can make colossal profits with a straight face,using mistakes for your own good. An absolutely cold, unclouded analytical mind is what you should strive for. Just imagine that you are a machine.

  1. Decide on the size of your deposit

Competent and consistent calculation of the amount of funds used for trading binary options opens up the opportunity for the trader to prudently and accurately approach each specific transaction. Again, here, as we said earlier, it is important to keep yourself within the range you set yourself.

It should be added that the deposit itself should not be formed from your last savings. In general, try to think through the various insurance strategies that will work for you personally. Every experienced trader always has a safety cushion that will allow him, even in the case of an absolute withdrawal of the deposit, after understanding all the mistakes, to enter the market again.

Let’s consider a more practical aspect: let’s say the minimum amount to buy a binary option is $ 10, in this case the deposit must be at least $ 500. The logic is something like this: If you are a beginner, then a balance of 50 minimum trades will be an excellent help for initial training. Even if you merge 15 out of 20 initial trades, the remaining balance will allow you to make up for the lost funds. Therefore, it is better to insure your deposit with a large volume, which can be broken down into a large number of small transactions.

  1. Trade with the trend

As you know, a trend is the direction of price movement at a certain point in time. There are the following types (trends) of market movement: downtrend (when the price goes down), ascending (upward respectively) and flat (sideways price movement).

By opening a trade with a trend, you are most likely to receive the expected profit and prevent possible risks. That is, if we are facing an upward trend, then we need to open a buy deal, and in the case of a downtrend, accordingly, open a sell deal.

  1. Learn to balance profit and risk

Experienced traders are constantly adjusting the balance between the benefits of a financial transaction and the risks that it may entail. At the same time, the risk limit is determined by the amount of funds at which, in the event of a lost transaction, the investor’s financial condition will not suffer critically.

Today, financial markets are one of the most attractive trading platforms, which has contributed to the development of numerous technical innovations that facilitate the trader’s work. The software ranges from all sorts of excel calculators all the way to special, multifunctional robot advisors, with sophisticated risk and benefit analysis algorithms.

  1. Plan your profitability

When choosing a broker , you should, first of all, pay attention to the key indicator of profitability: this is the profitability ratio. Each major broker negotiates its interest rate according to the correct forecast.

The easiest way to understand this will be the following example: Let’s say the price of an option contract is $ 200. The interest rate on the winnings is, say, 50%. If the contract wins, the trader will receive back his $ 200 plus $ 100 in net profit.

  1. Minimize losses

Everything is simple here. There is a list of rules known as Stop Trade. Below you can find three key ones:

– at the beginning of each trading day, you must determine the maximum number of options (deals) that you plan to open within each trading session;

– every trading day must open by calculating the limit on the number of unprofitable options, after exhausting which the trader must leave the market;

– also, it is necessary to determine a specific amount of income, having overcome which the trader must complete the current trading session.

  1. Diversify risks

Let’s say you were going to trade $ 300 in order to buy the EURUSD option. From the point of view of diversification (sharing) of risks, it will be more efficient to split this amount into several parts, for example, by 6 ($ 50 for each option contract) than to buy one three hundred dollar option.

Sometimes during the expiration of the option, subtle fluctuations can occur, which can lead you to a losing situation. In this case, you have a much better chance of reducing losses and even attracting profits if you split the amount into several different contracts. Risks can be diversified by setting different time ranges for each contract using different assets or trading strategies.

  1. Trade according to the system, strategy

Every effective trader trades according to his own trading system, which is constructed from experience, individual preferences and strategies of the trader, observations, indicators , conclusions, and so on. In other words, a trading system is a whole inventory of useful tools, general provisions and approaches that a trader uses when working in financial markets.

It is worth noting that such systems, in principle, exist in any work, be it house-building, real business or scientific activity. The presence of such defines a person as a specialist, and the absence, most often, betrays some kind of incompetence in him.

Before you develop your own trading system, we suggest you pay attention to two classic effective systems that you can fully use in the early stages of money management.

  1. Kelly criterion or formula and flat as a money management system

Kelly’s formula is widely known both in the financial markets and in the field of gambling. It is for them, you need to make a reservation, that the bet optimization system was originally developed within the framework of the Kelly formula.

In 1956, the American mathematician John Kelly compiled a very curious money management system. From the point of view of gambling, or in the process of trading binary options using this system, you can determine the optimal rate (and, accordingly, the value of the contract). In Kelly’s terms, this is an investment aimed at minimizing the risks of losses for a certain number of trades N, or at optimizing profit growth, again for a certain number of trades.

Such a system, representing a fixed share of bets depending on the current trade balance, is often called flat (the term from gambling is meant, and not the usual flat for Forex). An experienced trader, most often, defines this share as 5% of the capital, without risking above this limit.

In an example, it looks like this. Let’s say you have $ 500 in your account, so your initial bet will be $ 25. Making a profit of, say, 70%, your account becomes $ 542.5, which means your next bet will be 5% of already $ 542.5, that is, already $ 26 or $ 27, depending on the fractional restrictions of your broker, but by no means more five%. This is a limit that is not violated one iota, once and for all. In the case of a losing trade, again, we act according to the old scheme, focusing on a 5% rate of the total account. Let’s say you lost $ 25 and your balance is $ 475. Therefore, your next bet will not be $ 25, but only $ 23, and then, if the contract is profitable, you will still compensate for the loss of $ 25, since your balance will be $ 514.1, which is $ 14.1 more than the original balance.

However, by calculating the flat according to the Kelly system, you are much more effective in optimizing the growth of your initial balance. This calculation is expressed in the following formula:

where f * is the optimal fraction of the unit rate

p is the winrate of a trading strategy, in other words, the ratio of the total number of winning trades to the total number of trades in general

q is the probability of loss, which is calculated as follows: q = 1-p

A is the estimated income from the transaction,

B is the estimated loss. B = 1, as a rule – because most often in the case of trading with binary options, the trader, with incorrect forecasting, loses the entire amount of the bet

So, the Kelly Formula, in the case of binary options trading, turns out to be quite simple

Let’s give an example. Let’s say the win rate is 60%.

Then p = 0.6 and q = 0.4. The yield is, say, 75%.

It turns out that A = 0.75.

Consequently, the optimal rate according to the Kelly criterion is calculated as follows (0.6 * 0.75-0.4) \ 0.75 = 0.066.

So, the optimal share is 6.6%. This is the coefficient that optimizes the risks of losses and increases the likelihood of capital growth. You can multiply the share by a coefficient from 0.2 to 0.5, in order to further reduce risks, however, this, accordingly, will slow down the growth of capital.

It is also worth mentioning two fundamental principles on which the Kelly criterion is based. They read as follows:

A bet can only have two outcomes: win or lose. In the case of trading binary options, there is a rare case of equality of quotes at opening and expiration, here we advise you to return the investment in a new deal.

Splitting the initial trade balance can be infinitely divided (however, here again, there is a nuance with the limitation of the minimum option value – each broker has its own minimum price)

The mutual use of flat and the Kelly system is the most effective approach to money management in the early stages. Kelly criterion allows you to slowly but surely increase the trade balance with minimal risk.

  1. Oscar Grind system

The Grind system, like the Kelly criterion, has become widespread in the gambling industry, but this system can also be successfully applied in financial markets. However, Grind himself was a famous roulette player who surprised his fellow players with a curious and profitable approach to this game. Unfortunately, he did not find binary options. However, it is now widely used in the financial market.

In some respects, the Grind system resembles the anti-martingale system. But if in the anti-martingale system you just need to set the investment limit, then the Grind system is focused on a specific minimum profit. The system itself is outlined in a number of basic rules:

– to determine the goal. Let’s say this goal is to earn 10% of the initial deposit – let’s say 10% of $ 500, that is, $ 50;

– determine the initial investment. Let’s say it can also be 10% of the deposit, the same $ 50. Here it is necessary to make a reservation that if the goal is proportionate to the investment, then the investment should be less. Let’s say that if our goal is $ 50, and the broker’s bet on a winning contract is 150%, then the maximum investment will be approximately $ 34;

– in the case of a non-profitable trade, the next one should be the same as the previous one. Let’s say your investment of $ 20 is lost, then the next one should also be $ 20

– in the case of a profitable transaction, the price of the next one is determined by the sum of the previous investment and a step equal to the initial investment. That is, if the first profitable investment was $ 20, then the second should be $ 40, the third $ 60, and so on;

– upon reaching a predetermined goal, say $ 50, the session ends and you must open a new one, if desired, with new conditions.

So, in the course of ten trades, five of which turned out to be losing, and the other five were profitable, we made a profit of twenty dollars, surpassing the set goal by two times. The losses did not promise to be large, but to achieve the goal it took as many as ten transactions. In the financial markets, the system works out excellently.

But it is worth noting that these are only indicative examples that you can follow in the early stages, however, we emphasize that over time, each trader must develop his own system, synthesizing the positive qualities of each of the other systems he has worked out. This is what distinguishes an experienced trader from a beginner.

  1. Money Management and money management – is there a difference?

Taking into account the fact that such concepts as money management and capital management are often identified in the Russian-speaking segment of the Internet, we have to make a reservation. Indeed, in general, these concepts are similar, but the concept of money management is more competent to apply to the sphere of risk management in relation to open transactions. Money management is formulated in a key rule: don’t put all your eggs in one basket (diversify and hedge risks)

And, in the end, we emphasize once again that the art of money management perfectly complements the inventory of effective trading strategies, as well as increases the level of necessary discipline and general financial culture. Learn to manage risk, dear friends, and don’t let risk rule you!

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